Markets

F&O traders beware! The margin of error is very small

KS Badri Narayanan Chennai | Updated on June 02, 2018 Published on June 01, 2018

Traders dabbling in equity derivatives are set to be pinched by higher margin commitments and liquidity net worth criteria imposed by the exchanges.

Traders dabbling in equity derivatives are set to be pinched by higher margin commitments and liquidity net worth criteria imposed by the exchanges. The new system, which was supposed to be effective from Friday, would now become operational from July 2, says an NSE circular.

Market regulator SEBI had directed the exchanges and clearing corporations to collect a variety of margins from trading members in the F&O segment, which included initial margin, exposure margin/extreme loss margin, calendar spread margin and mark-to-market settlements. Traders who are keen on derivatives trading should know about these margins, their computation and how they will impact their trading positions.

SPAN margin

The initial margin required for the positions is computed online and on an intraday basis, using a software called SPAN (Standard Portfolio Analysis of Risk). Sellers of options (both call and put) and holders of futures (both long and short), where the potential losses could be high, are required to have sufficient margin in their accounts. The SPAN system uses strike prices, risk-free interest rates, changes in prices of the underlying securities, changes in volatility and time-value to calculate the worst possible move in the security. For the exchanges, SPAN margin covers almost the entire risk for the day, minimising the systemic risk due to margin pressures.

In addition to SPAN margin, a premium margin is also to be charged to traders. The premium margin is the amount payable by the buyer of the option. Besides, an assignment margin is also to be levied on assigned positions towards interim and final settlement of obligations for options.

Exposure margin

Exposure or extreme loss margin is the margin charged over and above the SPAN margin. For index options and index futures contracts, 3 per cent of the notional value of a futures contract is to be levied. In case of index options, it will be charged only on the sellers.

For options and futures contracts on individual securities, the higher of 5 per cent or 1.5 per cent of standard deviation of the notional value of gross open positions in futures and gross short open positions in options will be charged.

In case of calendar spread positions in futures contracts, exposure margins will be levied on one-third of the value of open positions of the far-month futures contract.

The calendar spread position is granted calendar spread treatment until the expiry of the near or current month contract.

Exchanges disclose the applicable margin for the contract period at the start of the new cycle. While most of the contracts (non-volatile stocks) attract 5 per cent, there are exceptions — Reliance Communications is being charged an exposure margin of 11.87 per cent and PC Jeweller 11.63 per cent for June.

Mark-to-market margin

The mark-to-market margin is collected from a trader before start of trading on the next day. Mark-to-market loss is calculated by marking each transaction in security to the closing price of the security at the end of trading. In case the security has not been traded on a particular day, the latest available closing price would be considered as the closing price.

For shortfall in SPAN and exposure margins, penalty would be levied from the trade date and for non-collection of MTM losses, from the next working day.

The new measures may dry up liquidity in the F&O segment, at least initially, as SEBI wants retail investors to trade more in the cash segment. So, traders should be aware of the risks while trading in derivatives, especially on individual securities. Even if one is well prepared financially to meet any challenges posed by the new margin commitments, lack of liquidity may hurt their positions.

Published on June 01, 2018

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